Asymmetry in Cash Flows and Accounting Conservatism

Abstract

In this paper, I present evidence that the asymmetry in cash flows biases standard measures of conditional conservatism. First, the magnitude of the asymmetric timeliness coefficient decreases substantially (by 28–58%) when the dependent variable is accruals in the Basu (1997) model. Second, the results show that both accruals and cash flows are less persistent for firms with negative returns. This result suggests that the Basu (1997) asymmetric earnings change specification cannot distinguish whether the lower persistence of earnings is due to accounting conservatism or a result of real activities. Third, I show that extant non-price proxies for economic loss are very poor at identifying the sign of economic income. Finally, I replicate a recent study and demonstrate that inferences change when using accruals as the dependent variable and after controlling for variables that are the determinants of nondiscretionary accruals.

Keywords: Accruals, Asymmetric timeliness, Conditional conservatism, Sarbanes-Oxley Act

JEL Classification: M41